Will the Solar Lease Live Forever or Flame Out?

Leasing has made solar power an affordable option for tens of thousands of Americans and now account for more than 75% of the total residential solar market. SolarCity (NASDAQ: SCTY) has done more to expand the solar lease than any other company, while SunPower (NASDAQ: SPWR) and NRG Energy (NYSE: NRG) are following fast behind.

But is the solar lease the future of residential solar, or is it a fad that will fade away like so many other solar products? Let's look at where the market is today and where it's going.

In California, entire communities are being built with solar pre-installed on new homes. Source: SunPower.

Why solar leases work The solar lease became popular in large part because it made the expensive up-front cost of a solar system affordable for the average consumer. A company such as SolarCity, SunPower, and now NRG Energy, puts up the cost of building the system in exchange for a monthly payment, the same way people lease cars or houses. Generally, consumers save cost monthly because the power purchase agreement in the lease is lower than the cost of electricity from the utility, and they don't have to put any money down up front.

This is profitable for lease owners because they can efficiently take advantage of tax breaks by using tax equity partners and can get lower financing costs than a homeowner could, which results in high overall margins.

SolarCity workers install panels on a home. Source: SolarCity.

The real innovation came in taking all of these factors and packaging them in a way that's easy for the consumer to understand. Instead of trying to sell a $30,000 solar system that may have a rate of return that's difficult to understand, salespeople are selling a lower cost of electricity every month, which is easy to understand.

But there's reason to believe that the leasing business is under pressure over the long term, and that other products may dominate in the future.

Why the solar lease won't be the dominant paradigmWhat many question about the current lease market, myself included, is the assumptions made in selling leases to customers. A couple of recent price quotes from SolarCity for fellow Fools Jason Hall and Wade Michels show that the company (and presumably others) is using unrealistic projections to show more cost savings to customers than they'll actually see.

The SolarCity quotes, from Connecticut and California, show huge savings of $23,942 and $5,410 over 20 years in Jason and Wade's respective locations. But they assume that electricity costs will rise 4.8% annually from rates of $0.188 per kilowatt hour and $0.178 per kilowatt hour. The problem is that assuming high growth for utility rates inflates projected savings and flies in the face of both history and the solar industry argument that solar lowers the overall cost of electricity for everyone.

You can see below that SolarCity's assumed price increases in grid electricity exceeds the historical increases by a wide margin.

SolarCity Assumed Annual Increase

Actual Annual Energy Increase Since 1980

Actual Annual Energy Increase Since 2008

SolarCity PPA Annual Price Increase/kW-hr

Connecticut

4.8%

2.47%

-2.13%

2.9%

California

4.8%

2.17%

3.5%

2.9%

Source: Quotes from SolarCity.

The Connecticut quote assumed an initial power purchase agreement rate of $0.11 per kilowatt hour, increasing in cost by 2.9% each year over 20 years. By the end of the contract, energy would cost $0.195 per kilowatt hour. Savings calculation were done assuming an $0.18.8 cost of electricity from the grid, increasing 4.8% annually to a whopping $0.48 per kilowatt hour in 20 years.

The California quote assumed an initial PPA rate of $0.176 per kilowatt hour (due to fewer state incentives), increasing in cost by 2.9% each year over 20 years. By the end of the contract, solar energy would cost the homeowner $0.312 per kilowatt hour. Savings calculations were assumed a $0.178 cost of electricity from the grid, increasing 4.8% annually to $0.455 per watt in 20 years. In table form it looks like this:

20-year cost of grid electricity using 4.8% growth

20-year cost of grid electricity using average rate since 1980

SolarCity PPA cost of electricity in year 20

Connecticut

48.0 cents

30.6 cents

18.8 cents

California

45.5 cents

27.3 cents

31.2 cents

Source: Quotes from SolarCity. Author's calculations.

If we use the historical compound 20-year growth rate of electricity, the Connecticut quote still results in significant savings over two decades, but far less than the $23,942 quoted by SolarCity. The California quote would actually result in a higher cost of electricity from solar using the historical average growth rate.

What's important to understand is that the assumed growth rates of both grid and solar PPA costs matter. If PPA rates rise faster than the actual cost of power from the grid, the cost savings per month decreases rather than increasing.

This is important for leasing companies because nationwide, like I've shown in Connecticut, utility rate growth is actually slowing. This is partly due to slower demand growth around the country, but it's also helped by solar panels generating power during the day, offsetting the most expensive power purchased by utilities.

A solar home community installed by SolarCity. Source: SolarCity.

The real threat to the solar lease I don't write any of this to suggest that the residential solar market will shrink. In fact, I think it will continue to spread rapidly across the country. I just think long term it makes more sense to use different financing.

The alternative to the lease will be the solar loan, and that's where I think we'll see real innovation over the next five years. Loans allow for a consistent monthly payment and enable the homeowner, not the leaseholder, to take advantage of tax breaks.

In the examples I've used above, the Connecticut solar PPA payment of $74 per month implies a 5.9% annual rate on the interest of a loan for the $15,158 purchase option after incentives, while the California system implies an 8% interest rate ($80 monthly/$12,005 purchase price).

Mortgage rates are currently lower than both of those rates, so it's reasonable to assume that homeowners could buy the solar system for $0 down and a lower monthly payment if solar loans can command the same rates as a mortgage. Plus, at the end of 20 years the system is yours.

If loans can be sold and structured to take advantage of federal and state incentives, and allow homeowners to go solar for $0 down, I think that will be the dominant financing product in the long term.

Why leases won't last as the dominant solar productI think solar leases are ultimately like car leases. They'll eventually have maybe 20% market share in solar, but won't be the dominant product like they are today. Leases on cars offer similar benefits, such as lower initial monthly costs, but similar pitfalls, including owning nothing when the lease is over.

I also wonder how long SolarCity and SunPower can generate upward of $2 per watt in retained value when system costs are between $3 and $4 per watt before any incentives, and falling. That's an incredible 30% to 40% implied margin, something you won't see in any other home construction business.

There are good reasons leases have become the dominant financing product for residential solar today, but as installation costs fall and more financing options become available I think that dominance will fade.

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Travis Hoium manages an account that owns shares of SunPower and personally owns shares and is long options. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Thank you Travis for your analysis. I would like to also add that two currently available alternative forms of solar financing, FHA $0 down Title 1 solar loans and PACE (HERO) $0 down solar financing both offer tax deductible payment interest which further tilts the table toward loans vs a lease or PPA. Solar leases and PPAs do not offer tax deductible interest.

In addition, an average size 4.75 kW solar system that will produce approximately 600 kilowatt hours per month with 5 hours of peak sunshine per day is no longer priced at $20,000 to $30,000.

Today a 4.75 kW system can easily be purchased from many sources for under $10,000 installed, after applying the 30% federal tax credit.

The benefit you get from the lease vs a loan that you overlooked is the maintenance and monitoring. If you own it who is watching for when your inverter goes kaput, you are. Who has to make the call to fix it, you do. Who has to pay for that, you do. With the lease you just pay the bill and Solar City fixes it.

@DWW12 A typical lease will cost the home owner three times the cost of an outright purchase so it is the homeowner, who is paying for their own maintenance and monitoring many, many times over, not the leasing company.

For example: For example: A 4.75 kW system in California will typically cost the consumer $117.00 per month for 20 years for a total cost of $28,080. The same 4.75 kW system would cost the consumer $9,642 after applying the 30% federal tax credit. That's a difference of $18,438 that would overpay for maintenance and monitoring many times over and would still leave the consumer with money.

And that's without adding in the $2.9% annual payment escalator that the leasing companies are fond of adding into their contracts. Add in the annual payment escalator and the cost to lease a solar system rises substantially.

If you think that with a lease that you'll simply pay the bill and the leasing company will take care of things with no cost to you, then you're dreaming.

With Leases and PPA's when the home owner sells their property they are at the fate of the Solar Company's sales person who is handling the transfer/lease assumption, with the potential buyer. If potential buyers knew that they had zero/no obligation to assume the existing Solar agreement I bet 80% of them would not! Solar companies generally do not disclose to the buyers that the agreement is the Sellers responsibility and it runs with the seller and not the property! Who in their right mind would assume a payment stream and a system that was designed for someone elses usuage? Solar City is banking on 90% renewal of their exisiting agreements. It would be interesting to see what the conversion ratio is for current customers selling their homes and how big the loses are for having to renegotiate the sellers agreement so it makes sense for the new buyer..

It'll be interesting to see how the market digests the promise of a 30-40% cheaper storage battery available with a SCTY lease package. I know there are A LOT of assumptions to be made about how much utility companies will buy back electricity for, life span of a storage battery, etc..

In my opinion, the storage battery angle will keep SCTY propped until it's PROVEN it has no benefits.

Not to mention, all other benefits Solar City will gain from being a partner in the giga factory. Competitive factors such as recycling will be a consideration. Plus the revenue they will get from contracts from Tesla to build out the solar infrastructure at the giga and charging stations.

The best deal out there is the pre-paid lease. I leased a 7kW system from Sunpower 2 yrs ago for under $10k after all the incentives and discounts. Net paybakx is under 4 yrs. if/when I buy an electric car, I can knock off another 1.5 yrs on the payback. Sunpower has to maintain the system and guarantees annual output. Those benefits are typically not available for a direct purchase or loan. Sunpower got the tax credit and can depreciate the asset (I as a homeowner can't). I believe the system would have cost well over $30K had I purchased directly. Payback after 30% tax credit would have been 8+ yrs. Pre-paid lease is the best deal out there.

You probably won't get that same deal from SunPower today because most of the rebates that existed two years ago have now expired. Besides SunPower now has some pretty stiff competition now that Hyper X Solar has hit the market.

Hyper X Solar's N-Type, thin film passivated, tunneling junction architecture provides high efficiency, a smaller footprint and a much lower cost which makes Hyper X solar's price/performance ratio hard to compete against when compared to many of the solar lease and PPA company's poorer performing offerings.

Hyper X solar also offers an incredible -0.27%/degree C temperature coefficient rating for better performance in hot/warm climates and best of all Hyper X solar systems are priced thousands less and even tens of thousands less on larger systems than a SunPower solar system.

30% to 40% cheaper than Lithium Ion storage battery solutions already exists in the form of L.A. AGM technology. Even at their much lower pricing, nobody has yet been able to make off grid applications pencil out when compared existing grid service.

I know because we've sold off grid systems nationwide since 1997. In fact we own offgridsolar .com and have sold thousands of off grid systems in the past 16 years. Believe me, if safe, cost effective technology existed that was cheaper than Lead Acid AGMs, We'd already be offering it.

Despite all the hype concerning the eventual introduction of a "Gigafactory", cheap Li-ion battery technology will be nothing but a pipe dream for at least the next 6 to 8 years.

So, bottom line is that today and for at least the next few years, there is no "storage battery angle" to keep any company propped up.

"The benefit you get from the lease vs a loan that you overlooked is the maintenance and monitoring."

LOL. There is virtually zero maintenance. Glance at the website and make sure it is still working. Big deal. With a microinverter based system, if one breaks then just replace it. Covered by the warranty.

Boy....Are there really this many dummies on this site?? ANSWER: YES!!

Now the facts: I have a Solar City "true lease" system (Not a PPA) I have NO yearly increases built into my twenty year lease, so my costs are ACTUALLY FIXED FOR THE NEXT TWENTY YEARS!! No money down, no maintenance, no costs to repair ANY aspect of the system for the next twenty years! THIS CAN ALL BE NEGOTIATED!! Right now I am saving $200 per month over what my same usage would be under SDG&E's tired residential rates! I have a large 18.75KW system that in San Diego county, CA will produce about 28,000 KWh's per year.....That is more than I will use so I will get a check back every year after my "true up" is done for my "net metering" lowering my costs even more! PS: ronwiserinvestor is a Solar System seller and installer who cannot offer leases so take EVERYTHING he says with a grain of salt!

@chrischamb1 Wrong. There is no such thing as a $0 down solar lease with no payment escalator and a low lease payment today. You have three choices,

1. Provide a down payment and avoid the annual payment increase (escalator).

2. Pay nothing down and get stuck with a much higher lease payment

3. Get stuck with up to a 2.9% annual payment increase.

In true solar lease salesman style, you conveniently left out a whole lot of information, cherry picking the the information that you presented.

For instance, when did you sign your lease contract? I'll bet it was when SDG&E offered their huge cash rebate. Well that rebate is now long gone so the leasing companies are longer offering the deals that they were once offering.

What is your monthly payment on that 18.75 kW system. I'll bet that you can buy that same system for less than half and possibly 1/3 the cost of your total lease payments.

I'll bet that your monthly payments are so high that when compared to a purchase, it is you who will be paying for your own maintenance and repairs many, many times over.

In addition, since you chose a lease instead of a loan, you missed out on 20 years worth of tax deductible payment interest. Too bad.

And your wrong. Nearly any dealer can offer leases in today's market. We deliberately chose not to offer leases and PPAs because after 16 years in the PV business, we have a reputation to protect and we feel strongly that in most cases offering leases and PPAs to our customers is simply unethical.

So on the contrary, chrischamb1 is either a solar lease company investor who is trying to make money on his investment or he is a solar lease company salesman who is trying to protect his job. Either way take EVERYTHING he says with a grain of salt!

I've been selling grid tie inverters for more than 14 years of my 16 year PV career and I know of no "typical" inverter that sells for $5,000 without installation.

We sell sell a high performance, high quality SolarEdge 5 kW inverters for less than $1,400 and the SolarEdge inverters in our systems include a 25 year warranty. And the cost to remove and replace that inverter after the labor warranty has expired, Typically less than $200.

"Will the panels withstand 20 years of storms without damage?" That's what your homeowner's insurance is for.

"What is the cost to replace them?" Covered by your homeowners insurance if damaged or covered by the 25 year manufacturers warranty should they fail to produce power.

"The tesla battery will not last 20 years." I don't know what you're smoking? (no pun intended) but there are no Tesla batteries in a leased solar system yet. That is unless you signed up to participate in their pilot program.

And finally for the 100th time, you don't need any money to put down on a $0 down solar loan with tax deductible interest.

The first question solar lease companies ask is, "Do you own your house?" Then they (for all intents and purposes) attach a permanent structure to it. Now, you don't own it, but since it is attached to your house you are completely responsible for fulfilling the lease terms of your solar PV system. It's basically a interest only loan. They will not take back the array. You can not drive it back to the dealer and hand over the keys.

Now,imagine trying to sell your house with a solar lease that is 10 years into a 20 year lease. You either have to get the new owner to assume the lease (on his credit) -priced a decade ago with (likely) a 2-3% annual increase- or, pay it off yourself and hope you can negotiate some additional value from the buyer due to the value of the electricity produced by the array. Might be tough because solar, over the course of the leased system's 10 years, only has to come down a little in price and rise a little in efficiency for the new home buyer to say, "why should I take over a 10 year old lease with all the price increases for a system where you have gotten the 10 best years out of it, when I can buy my own brand new system (financed) for less?"

The leasing companies also say that they will value systems in the future at fair market value when a system is sold to the leasee . It is a reasonable scenario where a system may actually rise in value when electric rates rise considerably. Remember, you cannot detach it from you house ans sell it to someone else. You either have to get someone else (greater fool) to take it over or buy it yourself.

Solar power has a legal issue that's brewing, net metering. To make the systems justifiable states adopted net metering laws to pay an unusually high rate for customers providing power back into the grid.

The problem is not everyone can put a solar array on their house or property. Because of this some people are automatically excluded but still pay the extra costs for the subsidies that people with systems get. It's a law suit that's going to happen soon.